The global bond selloff is creating pain for bondholders—but also a better income opportunity for some taxable investors.
At MacroXX, we look at the big economic forces moving markets: inflation, interest rates, government debt, Federal Reserve policy, economic growth, and investor positioning.
But macro investing is not only about making broad calls on stocks, bonds, or the economy.
The most useful opportunities often appear in a specific part of the market. The big macro picture tells us where to look. The focused investment decision is where the potential payoff often comes from.
Right now, one area worth watching is the municipal bond market.
The Global Bond Selloff
Government bond markets around the world have been under pressure.
Long-term yields have risen in the United States, Japan, Germany, and the United Kingdom as investors worry about large fiscal deficits, growing government debt, inflation, geopolitical uncertainty, and heavy borrowing by both governments and corporations.
This is not just a story about the next Federal Reserve meeting.
Investors are demanding more compensation for holding long-term bonds. They are concerned that inflation may remain higher than expected, governments may continue to borrow heavily, and the supply of bonds may keep rising.
As of late August, the 10-year Treasury yield was around 4.71%, while the 30-year Treasury yield was approximately 5.25%.
That is bad news for investors who already own long-duration bonds. When yields rise, bond prices fall.
But for investors putting new money to work, higher yields can create a better opportunity.
Why Municipals Matter
Municipal bonds are especially interesting for investors who hold bonds in taxable brokerage accounts.
Municipal-bond interest is generally exempt from federal income tax. Depending on the investor’s state of residence and the bonds held, the interest may also be exempt from state and local income taxes. Investors should still review the tax treatment of individual bonds and funds, including whether the income is subject to the Alternative Minimum Tax.
Investors should also check whether a municipal bond is subject to the Alternative Minimum Tax, or AMT. The AMT is a separate federal tax calculation that limits certain deductions, exclusions, and tax preferences, requiring some taxpayers to calculate their tax liability under both the regular tax system and the AMT system and pay the higher amount. Interest from certain private-activity municipal bonds can be included in AMT income, which can reduce the value of the bond’s tax exemption for affected investors.
They should compare the after-tax yield.
For example, a 10-year AAA municipal bond yielded around 3.19% in late August. That looks lower than the 4.71% available on a 10-year Treasury.
But for an investor in the top federal tax bracket, including the 3.8% Net Investment Income Tax, that 3.19% tax-free yield is equivalent to earning about 5.39% on a taxable bond.
That is higher than the 10-year Treasury yield.
For a high-income investor, a municipal bond can therefore offer more income after taxes, even though its stated yield looks lower.
The opportunity appears most attractive in the intermediate part of the curve—roughly five to 15 years. Investors can potentially earn solid tax-efficient income without taking as much interest-rate risk as they would by buying 20- or 30-year bonds.
Why the Timing May Help
The municipal market has also been dealing with heavy new issuance.
By mid-August, long-term tax-exempt municipal issuance had reached nearly $338 billion, about 39% above the five-year average. More than $40 billion of additional issuance was expected in September and October.
Heavy issuance can push prices lower and yields higher. That is not good for current bondholders, but it can create better entry points for investors who want to add municipal exposure.
Municipal funds and ETFs have continued to see investor inflows, and overall credit conditions have remained relatively stable.
Still, investors should not treat municipals as risk-free.
Municipal bonds carry interest-rate risk, credit risk, liquidity risk, and call risk. Some local governments and revenue-backed projects are much stronger than others. A high yield may reflect real problems with credit quality or liquidity.
The better approach is to focus on quality and diversification rather than chasing the highest possible coupon.
The MacroXX View
Municipal bonds are not a replacement for stocks.
Stocks still matter because investors need long-term growth, participation in corporate earnings, and exposure to innovation. Municipal bonds are designed to provide income and help preserve capital, not to produce equity-like returns.
Municipals are also not a full replacement for Treasuries.
Treasuries remain more liquid and carry no state or local issuer credit risk. They may be more useful during a recession, a financial-market shock, or a sharp decline in equities.
But for high-income investors with taxable accounts, municipals may deserve a larger role within the bond allocation.
The current macro environment has created higher yields, greater uncertainty about long-term rates, and more concern about equity-market concentration. Investors do not need to take as much stock-market risk just to earn income.
For the right investor, high-quality municipal bonds may provide a better after-tax return than comparable Treasuries.
That is the key point.
At MacroXX, we are not trying to replace every asset class with one trade. We are looking for the parts of the market where the macroeconomic environment has created a more attractive risk-reward opportunity.
Right now, for many high-tax-bracket investors, municipal bonds may be one of those areas.
This article is for educational and informational purposes only and should not be considered investment advice.